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Market Sense and Nonsense: How the Markets Really Work (and How They Don't) by Joel Greenblatt, Jack D. Schwager

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Prologue*

Many years ago when I worked as a research director for one of the major Wall Street brokerage firms, one of my job responsibilities included evaluating commodity trading advisors (CTAs).1 One of the statistics that CTAs were required by the regulatory authorities to report was the percentage of client accounts that closed with a profit. I made the striking discovery that the majority of closed accounts showed a net loss for virtually all the CTAs I reviewed—even those who had no losing years! The obvious implication was that investors were so bad in timing their investment entries and exits that most of them lost money—even when they chose a consistently winning CTA! This poor timing reflects the common investor tendency to commit to an investment after it has done well and to liquidate an investment after it has done poorly. Although these types of investment decisions may sound perfectly natural, even instinctive, they are also generally wrong.

Investors are truly their own worst enemy. The natural instincts of most investors lead them to do exactly the wrong thing with uncanny persistence. The famous quote from Walt Kelly’s cartoon strip, Pogo, “We have met the enemy, and it is us,” could serve as a fitting universal motto for investors.

Investment errors are hardly the exclusive domain of novice investors. Investment professionals commit their own share of routine errors. One common error that manifests itself in many different forms is the tendency to draw conclusions ...

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